Late Stage College PlanningFinancing college tuition, fees and expenses can be daunting.  However, taking advantage of student loans may help lighten the financial burden.  There are several type of loans available, both good and not-so-good.  Primarily, students can get access to Federal student loans and/or private student loans.

Typically, Federal student loans offer borrowers lower interest rates and have more flexible repayment terms and options than private loans.  Federal loans are borrowed funds that you must repay with interest.  Private student loans are nonfederal loans issued by a lender such as a bank or credit union.

Federal Student Loans

Federal student loans are generally better for students.  They typically offer benefits not found in private loans.  These benefits include things such as low fixed interest rates, income-based repayment plans, cancellation for certain professional jobs and deferment (postponement) options in the event the student goes back to school.  They also do not require a credit check which is required private institutions.

Type of loan Who’s eligible Interest rate
(2016)
Loan limits
yearly/lifetime
Perkins Loans Only the most needy college students 5% Undergrads: $5,500/$27,500
Grad students: $8,000/$60,000
Subsidized
Stafford Loans
Determined by Free Application for Federal Student Aid (FAFSA) 4.29% $3,500–$5,000 depending on grade level
Unsubsidized
Stafford Loans
Everyone who files a FAFSA 4.29% for undergrads

5.84% for grads

$5,500-$20,500 (less any subsidized amounts received) depends on grade level and dependency status
Parent PLUS
and Graduate
Student PLUS Loans
Those who meet the eligibility requirements and do not have an adverse credit history 6.84% Undergrads and graduate students: the cost of your college’s annual tuition and room and board, minus financial aid

 

State Loans

Another option is to look to what your state has to offer.  Each state has its own eligibility requirements.  Some states require that a student attend college in that states while others do not.  Typically, the interest rates on these types of loans are between 4.5% and 8.5%.

Using Your Home Equity

Home equity loans and home equity lines of credit are options as well.  A credit check is needed but the interest rates are generally low for qualified borrowers.  The amount that is borrowed is based on the difference between what the your house is currently worth and how much you’ve already paid on your original loan.  In some cases, the interest paid on the loan can be tax deductible.

In the same vein, a cash-out refinance of an existing mortgage can provide the funds needed to pay for college.  These types of mortgages can come with fixed, variable and adjustable interest rates and typically offer longer terms of repayment than home equity loans.  As with home equity loans, the interest paid may be tax deductible.

A word of warning on using a home to pay for your child’s college education … you are guaranteeing these loans with your home.  If you cannot make the payments on the loan, the lender can foreclose on the loan and you can lose your home.

401K Loans

This is an option, but not necessarily a good option.  Always remember, your child can borrow for college, but you cannot borrow for retirement.  Most 401k plans have loan provisions that, by law, maximize the loan amount to 50% of the vested account balance and it must be repaid within five years through payroll deductions.  The interest rate is set by the plan and is usually tied to the prime rate.  Five years is a short period of time.  If you fail to do so, the unpaid balance of the loan is treated as a non-qualified withdrawal subject to income tax and a 10% penalty.

Private Student Loans

Private student loans are the loans-of-last-resort.  They typically have higher fees, more acceptance requirements, inflexible payment options and generally require a cosigner (e.g. the parents who are on the hook to pay for the loan if their child does not).  They are offered to students by a variety of banks and private lenders and can carry interest rates as low as 3% and as high as 12% so be careful to choose the most cost effective loan package.

Life Insurance Policy Cash Value Loans

Whole life, variable life and universal life insurance policies all have a cash value component that can be borrowed against.  The cash value is a portion of your policy’s death benefit that has become liquid.  The interest rates for loans on these types of policies will vary based on the policy.  Since the cash value is considered to be yours, you decide on when to repay the loan.  There are several things to consider before using this type of loan.  First, if you die without having paid off the loan, the benefit is reduced by the loan amount.  Second, if you don’t pay off at a minimum, the interest on the loan every year, this interest will continue to accrue and slowly eat away your death benefit.  At some point, there is no cash left and the policy will no longer be in force … even if you continue to pay the premium.

And Finally ….

For parents, it’s critical to make sure helping their child pay the college tab won’t shortchange their own home, retirement savings, or other short- and long-term financial goals.  It’s also important to only take out loans that are needed to pay for education-related costs.  Even though you and/or your child may qualify for more, the total loan will need to be paid back with interest.  Taking out more than can be repaid may have consequences for many years after your child has graduated from college.

Know your options.  Talk to your trusted financial advisor to better understand the options available and how your decision could affect your future financial independence.  You can also contact Mackey Advisors, the Prosperity People.  Our clients get the clarity to make better decisions and the confidence to take action.